Confused about escrow? You’re not alone – many first-time home buyers are. But the truth is, escrow doesn’t have to be so complicated! In essence, it’s a simple concept and usually makes budgeting easier for homeowners. So what is it exactly? Basically, it involves a third party who ensures that both parties meet their obligations when money or other assets are exchanged between them. It’s commonly used in business as a way to prevent either side from being taken advantage of.
Check out our Real Estate Dictionary definition of Escrow:
Escrow is often confusing because it comes up twice when dealing with home ownership. The two occasions are:
When closing on a home, escrow is used to hold “earnest money”, which shows good faith, and also is “skin in the game” from the buyer.
As part of the mortgage payment, you have a long-term escrow account where you pay your property taxes and insurance each month.
To help clear things up, here is information regarding the most commonly asked questions about escrow. Keep in mind that while there are federal regulations dictating certain parts of escrow, states and banks may also do things their own way.
When buying a home, being “in escrow” typically lasts for at least 30 days between when an offer with a cash deposit has been accepted and the day of closing. This deposit, which is often referred to as earnest money, is held in escrow until an agreement on the sale has been reached. Therefore, if you have any doubts or questions concerning escrow issues, it is recommended that you contact a local Realtor. We are always happy to help.
An escrow account is typically established during closing and will eventually be managed by the loan servicer. The purpose of this account is to collect and store a portion of the mortgage payment for property taxes, mortgage insurance, and sometimes even homeowners insurance (not all lenders require it). Depending on where you live, this middleman might be an individual escrow agent, an attorney, or a title company. In Oregon, we use title companies, and have escrow officers that oversee the process. The earnest money is part of the down payment, and is applied to the purchase price at closing.
At closing, a title agent, attorney, or servicer will take care of setting up the escrow account for you–so no need to worry about that. Additionally, lenders often require buyers to put in two months’ worth of estimated payments for property taxes, mortgage insurance, and homeowners insurance. This amount goes into the escrow account which works much like a savings account–except only your loan servicer can make withdrawals from it.
An escrow account is usually necessary to protect the lender’s investment in the property. Failing to pay property taxes could result in a lien on your home and potential loss of it. The lender doesn’t want someone else having a claim on their property, and if homeowners insurance lapses and there’s serious damage, then the lender’s investment would be at risk. The title company for instance has a “title plant” where they can verify chain of ownership for each property.
Waiving an escrow account may be possible if you have 20% equity, however, this increases the lender’s risk and may result in a higher interest rate for the loan. On the other hand, having an escrow account offers two advantages: money is put away each month for expenses instead of budgeting large payments and someone else manages the tax and insurance bills.
If you’re self-employed or earn commission, it might be easier to set aside money for taxes and insurance in bigger chunks during prosperous months rather than every month. Additionally, some homeowners like having full control over their finances. However, if you don’t want an escrow account, you must be very diligent in both saving and keeping track of your bills. The last question is: can I gain interest on my escrow account? The answer is likely, no.
In fifteen states, lenders are legally obligated to pay interest on escrow accounts. These states are Alaska, California, Connecticut, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Oregon Rhode Island , Utah , Vermont and Wisconsin. For those not living in these places who do not need an escrow account; it is possible to gain a small amount of interest by keeping the money in a savings account. However this is typically not profitable enough to cover even a moderate meal for two people.
Your escrow payments can fluctuate, as they may increase due to a rise in property taxes or your homeowners insurance premium. On the other hand, your payments could also decrease if the tax rate or assessed value of your home goes down. Additionally, if you are paying mortgage insurance, it will eventually be eliminated.
Annually, escrow payments are generally checked. Since the cash going into escrow is an estimate, it can sometimes lead to an adjustment where you get back a bit of money or owe some more. What if there’s a mistake in your escrow account? Despite it being unfair, even when your servicer is taking care of your property tax and insurance payments, you’re still responsible for making full and on-time payment. In rare cases, a mistake may leave the escrow account with not enough money to cover what the homeowner owes. There are several things to be aware of: at closing inspect math errors and make sure the correct tax rate is being used; research how property taxes work in your area; stay attentive to tax and insurance bills as well as their due dates (even though you’re not personally paying them); take note of both the balance of your escrow account and how much of your current mortgage payment goes into it – this will ensure that payments due have been sent out and that you’re up-to-date on covering all bills.
At tax time, homeowners can benefit from the deduction of property taxes on Schedule A; however, it is often easy to mistakenly deduct the amount placed in escrow rather than what was actually paid out. Mortgage payments are put into an escrow account to cover property taxes, but they are not paid out by the loan servicer until bills come due (usually twice or four times a year). To find out how much was paid out, refer to your loan servicer’s annual escrow analysis.
If you have any questions about escrow or the escrow process, call us at 503-288-3979.
We are happy to answer any questions.